Nominal GDP, Real GDP & GDP Deflator

In this post we will discuss the concepts of nominal GDP, real GDP, GDP deflator and inflation. Before going forward we must know what GDP is? Gross Domestic Product is the total market value of all final goods and services produced within a country in a year. To see more about GDP click GDP and its Components with Example.

Nominal GDP

Nominal GDP is the value of all final goods and services measured at curent market prices.

Nominal GDP changes when

• either price changes
• output changes
• Or both price and output changes

Nominal GDP does not truly reflect economy`s health because nominal GDP can increase even when prices increase but output remains the same.

Real GDP

Real GDP is the value of all final goods and services measured at constant prices of some base year.

Real GDP changes only when output changes. When output increases real GDP also increases, and when output decreases real GDP also increases.

The relation between real GDP, nominal GDP, and inflation can be represented by Fisher Equation.

Real GDP=Nominal GDP -Inflation

An Example of Nominal and Real GDP

Suppose that price of a T-shirt in 2015 was Rs. 300 per unit and its output was 1000 units, the total market values of T-shirt in 2015 was 300*1000=300,000. Thus, GDP in 2015 was Rs. 300,000. Now assume that in 2023 the price per unit of T-shirt increases to Rs. 500 but the output remains the same i.e., 1000 units. So, the GDP would be 500*1000=500,000.

Does it mean that GDP increases by Rs. 200,000 ? Yes, it has but only in nominal terms not in real terms. Nominal GDP is Rs. 500,000 in 2023 but real GDP is Rs. 300,000. The increase of Rs. 200,000 is just due to increase in price of T-shirts, which is called inflation.

Thus, we can say that Prices of T-shits increases by 66.67% between 2015 and 2023.

GDP Deflator

GDP Deflator is a measure of general price level which is calculated as the ratio of Nominal GDP to Real GDP. The GDP deflator measures the current level of prices relative to the level of prices in the base year.

Nominal GDP and Real GDP are the same for the base year. So, value of GDP Deflator in base year is always 100. To see why this is true, consider a couple of simple examples. First, imagine that the quantities produced in the economy rise over time, but prices remain the same. In this case, both nominal and real GDP rise at the same rate, so the GDP deflator is constant.

Now suppose, instead, that prices rise over time, but the quantities produced stay the same. In this second case, nominal GDP rises but real GDP remains the same, so the GDP deflator rises. Notice that, in both cases, the GDP deflator reflects what’s happening to prices but not to quantities.

Calculating Inflation using GDP Deflator

GDP Deflator is just an index for prices of goods and services produced domestically in the country. It tells us about the relative change in process from previous or base year.

To calculate inflation rate we use the growth rate formula because inflation is the percentage change in GDP Deflator.

The GDP deflator gets its name because it can be used to take inflation out of nominal GDP—that is, to “deflate” nominal GDP for the rise that is due to increases in prices.

An Example

To calculate nominal GDP, real GDP, GDP Deflator and inflation rate for each year use the following formulas:

Nominal GDP (2019)

Real GDP (2019 base year)

Nominal GDP (2020)

Real GDP (2020)

Nominal GDP (2021)

Real GDP (2021)

Nominal GDP (2022)

Real GDP (2022)

GDP Deflator (2019)

GDP Deflator (2020)

GDP Deflator (2021)

GDP Deflator (2022)

Inflation Rate (2020)

Inflation Rate (2021)

Inflation Rate (2022)

Suggestions for further reading

• Real Gross Domestic Product (Real GDP): How to Calculate It, vs. Nominal
• Nominal GDP and Real GDP Explained: Definition, Examples, Practice & Video Lessons
• Nominal GDP, Real GDP and GDP Deflator | Economics Tutorials